Sixth Street Specialty Lending Inc
NYSE:TSLX
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Sixth Street Specialty Lending Inc
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Good morning and welcome to the Sixth Street Specialty Lending, Inc.’s First Quarter ended March 31, 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Tuesday, May 9, 2023. I will now turn the call over to Ms. Cami VanHorn, Head of Investor Relations.
Thank you. Before we begin today’s call, I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time-to-time in Sixth Street Specialty Lending, Inc.’s filings with the Securities and Exchange Commission.
The company assumes no obligation to update any such forward-looking statements. Yesterday, after the market closed, we issued our earnings press release for the first quarter ended March 31, 2023 and posted a presentation to the Investor Resources section of our website www.sixthstreetspecialtylending.com. The presentation should be reviewed in conjunction with our Form 10-Q filed yesterday with the SEC.
Sixth Street Specialty Lending, Inc.’s earnings release is also available on our website under the Investor Resources section. Unless noted otherwise, all performance figures mentioned in today’s prepared remarks are as of and for the first quarter ended March 31, 2023. As a reminder, this call is being recorded for replay purposes.
I will now turn the call over to Joshua Easterly, Chief Executive Officer of Sixth Street Specialty Lending, Inc.
Thank you, Cami. Good morning, everyone and thank you for joining us. With us today is my partner and our President, Bo Stanley; and our CFO, Ian Simmonds. For our call today, I will provide highlights for this quarter’s results and then pass it over to Bo to discuss activity levels in the portfolio. Ian will review our quarterly financial results in detail and I will conclude with final remarks before opening the call to Q&A.
After market closed yesterday, we reported first quarter financial results with adjusted net investment income per share of $0.55 corresponding to an annualized return on equity of 13.3% and adjusted net income per share of $0.67 corresponding to an annualized return on equity of 16.3%. From a reporting perspective, our Q1 net investment income and net income per share, inclusive of accrued capital gains incentive fee expenses was $0.53 and $0.65 respectively. As a reminder, the $0.02 per share is a non-cash expense, which was not paid or payable and is related to accrued fees on unrealized gains from the valuation of our investments.
This quarter’s net investment income reflects the continued strength in the core earnings power of our portfolio and the annualized return on equity metrics are above the guidance we provided on our last earnings call. Net investment income was largely the result of elevated portfolio yields driven by higher underlying reference rates. Activity-based fees represented only 3.6% of total investment income for the quarter. Year-over-year, total investment income has increased 43%, largely driven by asset sensitivity from higher interest rates in our floating rate investments. We expect that the interest rate environment will continue to support core earnings without the impact of any activity related income based on our base dividend level.
Further, we believe there is potential upside relative to this quarter’s 13.3 annualized return on equity on adjusted net investment income as we generate incremental earnings from payoffs and other activity-based fees. The difference between this quarter’s net investment income and net income was predominantly a result of unrealized gains from tightening credit market spreads on the fair value of our portfolio and realized gains from certain portfolio company-specific events.
From a macroeconomic perspective, to say 2023 is off to an eventful start is an understatement. Through the first quarter of the year, we have experienced financial contagion fears following the regional banking issues, persistent inflation, sustained rise in interest rates and ongoing geopolitical factors, just to name a few. As part of our commitment to transparency and our communication with our stakeholders, during March, we published a letter outlining the positioning of our business as it relates to the most recent developments in the banking sector.
We encourage you to read our perspectives and welcome any feedback. But for today’s call, we will keep it simple by saying we don’t believe there are any material impacts to our business from these developments. If we take a step back and consider all of the opportunities and challenges presented by today’s macro landscape, we believe that TSLX is well positioned. We have built a defensive through-the-cycle business characterized by investments on top of the capital structure with low exposure to cyclical businesses.
Although our portfolio construction is bottoms up in nature, we continue to be mindful of the impact of certain macroeconomic indicators that can influence both the performance of our existing portfolio and the opportunity set ahead of us. At quarter end, net asset value per share was $16.59, up $0.20 per share or 1.2% from adjusted net asset value per share at year end of $16.39. This growth was primarily driven by continued over-earning of our base dividend and net unrealized or realized gains from investments.
Yesterday, our Board approved a second quarter based quarterly dividend of $0.46 per share to shareholders of record as of June 15, payable on June 30. Our Board also declared a supplemental dividend of $0.04 per share related to our Q1 earnings to shareholders of record as of May 31 payable on June 20. Our Q1 ‘23 net asset value per share adjusted for the impact of the supplemental dividend is $16.55. We estimate that our spillover income per share at quarter end is approximately $0.87.
As part of our focus on capital efficiency, in conjunction with our board, we will review the level of undistributed income as the year progresses to ensure we minimize potential return on equity drag resulting in excise tax. At some level, this will likely require the payment of additional distributions to our shareholders similar to how we address this in 2020 and 2021.
With that, I will now pass it over to Bo to discuss this quarter’s investment activity.
Thanks, Josh. I’d like to start by sharing some observations on the broader market backdrop, in particular, the secular shift towards private credit that has been a persistent theme over the last few quarters. We believe the opportunity set for our business is the greatest we have seen in recent history and at least since the global financial crisis. The development in the financial sector has further increased market share for direct lenders as banks are tightening credit and public markets remain unreliable in light of heightened economic uncertainty.
As a result, nearly every financing opportunity is coming to the private credit market due to the flexibility and execution and certainty that direct lenders with capital are able to provide. This shift has been a positive for our business as we continue to build a robust pipeline while remaining selective. Broadly speaking, M&A and LBL activity have meaningfully slowed, but the scale and quality of companies refinancing has generally improved given the shift towards private credit.
We remain active during the quarter with commitments and fundings totaling $176 million and $139 million respectively. This was distributed across 7 new and 5 upside to existing portfolio companies. On the repayment side, higher interest rates and the lack of more traditional capital market financing alternatives have led to a slowdown in refinancing activity, resulting in less portfolio turnover over the last couple of quarters. We had one full and three partial investment realizations totaling $51 million in Q1.
Consequently, activity-based fee income remained muted. Our full payoff during this quarter was our investment in WideOrbit, which is a provider of TV and radio traffic management software. As a reminder, we made our initial investment in July of 2020 in the COVID-driven market dislocation. Our ability to play offense during this time, not only benefited the company in this need for refinancing, but also allowed us to structure the transaction with favorable terms for shareholders, including potential upside through ownership of warrants.
In February, the company was acquired by the Lumin Group, which included a repayment of the outstanding balance on its credit facility and proceeds to outstanding warrant holders. TSLX received $5.2 million in proceeds from the sale of our warrants, resulting in a realized gain of $4.8 million or $0.06 per share and generated a blended IRR and MOM on our total investment of approximately 17% and 1.4x respectively.
To touch on investment themes during the first quarter, sponsor activity in the upper middle-market remained active given the uptick in public to private transactions. More broadly, across the middle-market, activity levels were generally slower in Q1. But for the deals that we are getting done, capital scarcity at size created an opportunity for our business due to a substantial pool of capital across Sixth Street’s platform.
One example that highlights this theme was our investment to support [indiscernible]. With a total transaction value of $8 billion, Sixth Street played an important role in providing financing given the size of our capital base and knowledge in the software space. Both of these differentiators, in addition to our relationship with the sponsor, allowed us to structure and lead the underwriting process. In addition to making new investments, we remain very focused on active portfolio management, including monitoring the health of our existing portfolio companies.
Elevated interest rates and sustained inflation has created a more challenging operating environment, especially for those with high fixed cost obligations. 82% of our portfolio by fair value was characterized by software and business services companies as of quarter end. We favor the durability we see in these sectors in particular given the variable cost structure provides us the flexibility to implement more immediate cost savings in the event bookings or top line growth flows in an environment of broader economic slowdown. Today, the performance of our portfolio of companies remains solid, demonstrated by quarter-over-quarter revenue and EBITDA growth of 9% and 17%, respectively. As Josh mentioned, we have constructed our portfolio to withstand all types of operating environments and we feel good about the overall health of our current portfolio.
I’d like to take a moment to provide an update on one of our existing investments, Bed, Bath & Beyond. As publicly disclosed on April 23, Bed, Bath & Beyond announced that it would be voluntarily filing for bankruptcy to implement an orderly wind down of its business while conducting a limited marketing process to solicit interest in one or more sales of some or all of its assets. This filing and the voluntary nature of it is a positive development for our investment. Instead of the company potentially attempting to fund continued losses, we believe a shorter time period optimizes recoveries on our collateral and for creditors in general. The company also announced that Sixth Street has aging of existing 5 lenders would be contributing $240 million in debtor in possession financing to provide liquidity for operations through the Chapter 11 process. But this is comprised of $40 million in new fundings, of which $5.9 million was funded by TSLX, with the rest being a rollover from previously funded commitments amongst the lender group. Including our position of the dip, TSLX has funded $76 million related to Bed Bath & Beyond to-date since our initial investment in September of 2022.
At this moment, we feel confident about the recovery of our investment at fair value. We would also note that there is potential upside above fair value as our total claim amount includes previously capitalized make-whole amounts, which could positively impact earnings in the range of 0 to $0.105 per share net of incentive fees. When we made our initial investment, it was to provide liquidity and to support the turnaround of an iconic brand which we felt had real potential to rebound if the right strategy was put in place. Unfortunately, that hasn’t happened. It’s a 50% drop in same-store sales during last year’s holiday seasons and significant operating losses in Q1 were too much to overcome for the business to continue in its current form.
While liquidation was not the desired outcome, it was the base case from our underwriting approach. And as we have demonstrated before, we have core competency in these situations. Since we began investing through TSLX in 2011, we have executed over 25 transactions in our retail ABL team. And in each case, we underwrite with a liquidation scenario in mind. We have taken 9 of those 25 investments through the bankruptcy process. These processes are always fluid with this one being no different and we continue to work diligently to maximize value for our investors. Our recoveries will ultimately be based on the underlying liquidation value of the assets of the business, which we will have more refined view on over time. We anticipate the liquidation process to take approximately 16 to 20 weeks.
Heading into the rest of 2023, we saw a pickup in activity beginning in March and we are optimistic about our originations and funding pipeline. The fact that we are in a strong position from a capital liquidity perspective, as Ian will discuss, provides us with meaningful competitive advantage in the current environment. As for repayment activity, we generally expect less churn in our portfolio through the course of the year. However, we do anticipate opportunistic and idiosyncratic events will drive payoffs.
Deal flow and repayment activity are largely a byproduct of macroeconomic factors at play, but we continue to pick our spots to remain selective. We will opportunistically deploy capital in areas where our platform’s ability to underwrite and navigate complexity allows us to create excess returns across our portfolio. From a portfolio yield perspective, funding and repayment activity this quarter had a positive impact to our weighted average yield on debt and income producing securities at amortized stock. Yields were up to 13.9% from 13.4% quarter-over-quarter and are up about 350 basis points from a year ago. The weighted average yield at amortized stock on new investments, including upsizes this quarter was 13.8% compared to 13.2% on exited investments.
Moving on to the portfolio composition and credit stats, across our core borrowers, these metrics are relevant, we continue to have conservative weighted average attach and detach points on our loans of 0.8x and 4.4x respectively and their weighted average interest coverage remained stable at 2.2x. As of Q1 2023, the weighted average revenue and EBITDA of our core portfolio companies was $165 million and $54 million, respectively.
Finally, the performance rating of our portfolio continues to be strong with a weighted average rating of 1.16 on a scale of 1 to 5 with one being the strongest. We continue to have minimal non-accruals at less than 0.7% of the portfolio at fair value with no new portfolio companies added from prior quarter. The increase in the notional quoted value from the prior quarter reflects another tranche of our investment in American achievement being placed on non-accrual during the quarter. This was a COVID-impacted business that has had difficulty recovering after missing 1 and 1.5 selling seasons and the relatively weakening of their competitive position in their industry. American achievement continues to be our only portfolio company on non-accrual status.
With that, I’d like to turn it over to Ian to cover our financial performance in more detail.
Thank you, Bo. For Q1, we generated adjusted net investment income per share of $0.55 and adjusted net income per share of $0.67. Total investments were $2.9 billion, up from the prior quarter as a result of net funding activity. Total principal debt outstanding at quarter end was $1.6 billion and net assets were $1.4 billion or $16.59 per share, prior to the impact of the supplemental dividend that was declared yesterday.
Our average debt-to-equity ratio increased slightly quarter-over-quarter from 1.14x to 1.17x and our debt-to-equity ratio at March 31 was 1.2x. The increase was driven by portfolio growth from new investments combined with minimal repayment activity. After the recent announcement from Bed Bath & Beyond that Bo mentioned earlier, we now expect the $76 million in funded par outstanding to be paid down in the near-term, thereby decreasing leverage and increasing our capacity for new investment opportunities.
We continue to have ample liquidity with $603 million of unfunded revolver capacity at quarter end against only $190 million of unfunded portfolio company commitments eligible to be drawn. As part of the letter to our stakeholders, we published in March in response to the failure of Silicon Valley Bank, we shared aspects of our philosophy towards managing risks in our business. As we’ve witnessed through the last couple of months, it is not enough to merely satisfy minimum regulatory requirements. It is in the corner cases, the shocks with the strength or weakness of the operating model is truly apparent.
An understanding of this concept has guided the way we have structured our balance sheet in terms of both capital and liquidity. As it relates to capital, we operate within our previously established target leverage range of 0.9x to 1.25x, well below the regulatory limit of 2x largely as a way to preserve our reinvestment option to create high risk-adjusted returns. This has been purposeful as we know that it is in periods of volatility and market dislocation that great investment opportunities are created while capital generally becomes constrained.
Turning to liquidity. We think about our liquidity profile in terms of reserving for, one, all near-term maturities, of which we have none; two, unfunded commitments eligible to be drawn; and three, future pipeline investment opportunities, both known and unknown. As of March 31, liquidity represented 3.2x the amount of unfunded commitments eligible to be drawn.
Moving to our presentation materials. Slide 8 contains this quarter’s NAV bridge. Walking through the main drivers of NAV growth, we added $0.55 per share from adjusted net investment income against our base dividend of $0.46 per share. As Josh mentioned at the beginning of this call, there was $0.02 per share of accrued capital gains incentive fee expenses related to this quarter’s net realized and unrealized gains. There was a $0.22 per share positive impact to NAV primarily from the effect of tightening credit market spreads on the fair value of our portfolio.
And finally, other changes resulted in a $0.02 per share decline in NAV, which primarily included $0.08 per share from lower equity valuations, offset by $0.06 per share from realized gains. A large portion of the realized gains were driven by the payoff in February of our investment in [indiscernible].
Moving on to our operating results detailed on Slide 9. Total investment income for the quarter was $96.5 million compared to $100.1 million in the prior quarter. Walking through the components of income, interest and dividend income was $92.2 million up from $85.8 million in the prior quarter, driven by higher all-in yields and net funding activity. Other fees representing prepayment fees and accelerated amortization of upfront fees from unscheduled pay-downs were lower at $1.6 million compared to $11 million in Q4 given the minimal repayment activity we experienced in Q1.
Other income was $2.8 million compared to $3.4 million in the prior quarter. Net expenses, excluding the impact of the non-cash accrual related to capital gains incentive fees, were $51.4 million, up from $47.5 million in the prior quarter. This was primarily due to the upward movement in reference rates, which increased our weighted average interest rate on average debt outstanding from 5.4% to 6.7%, coupled with marginally higher average debt outstanding in Q1.
Before passing it over to Josh, I wanted to circle back to our ROE metrics. In Q1, we generated an annualized ROE based on adjusted net investment income of 13.3% and an annualized ROE based on adjusted net income of 16.3%. This compares to our target return on equity of 13% to 13.2% for the full year as articulated during our Q4 earnings call, and we maintain this outlook heading into the rest of 2023.
With that, I’ll turn it back to Josh for concluding remarks.
Thank you, Ian. I’d like to close our prepared remarks today by encouraging our shareholders of record to participate and vote in our upcoming annual and special meetings on May 25. Consistent with previous years, we are seeking shareholder approval to issue shares below net asset value effective for the upcoming 12 months. And to be clear, to date, we have never issued shares below net asset value under prior shareholder authorization granted to us for each of the past 6 years, and we have no current plans to do so. We merely view the authorization as an important tool for value creation and financial flexibility and periods of market volatility.
As evidenced by the last 9 years plus since our initial public offering, our borrow for raising equity is high. We’ve only raised equity when trading above net asset value on a very disciplined basis. So we would only exercise the authorization to issue shares below net asset value if there are sufficiently high risk-adjusted return opportunities that would ultimately be accretive to our shareholders through over earning our cost of capital and any associated dilution.
If anyone has questions on this topic, please don’t hesitate to reach out to us. We have also provided a presentation which walks through this analysis in the Investor Resources section of our website. We hope you find the supplemental information helpful as a way of providing a clear rationale for providing the company with access to this important tool. As a final part of today’s call, we want to address all the talk there has been about the current environment being the golden age for private credit. While we believe that there is a huge opportunity for private credit and direct lenders in today’s marketplace. We also believe there will be meaningful dispersion in returns for shareholders. To take advantage of the opportunity set requires a differentiated strategy, including the right human capital. It all starts with having the right team of people with expertise across sectors and industries who are positioned in the right seats to collaborate across connected platform.
We just returned from our annual Sixth Street off-site. We’re nearly our 500-person strong team gathered to work together and build relationships. This tradition continues to solidify the culture we’ve built and is essential to the success of our business and generating differentiated returns for our shareholders.
With that, thank you for your time today. Operator, please open the line for questions.
Thank you. [Operator Instructions] Our first question comes from the line of Kevin Fultz from JMP Securities.
Hi, good morning and thank you for taking my question. With the recent turmoil in the banking sector, I was curious if you’ve seen any change over the past 2 months in your ability to negotiate better terms on the new deals that you’re doing in the forms of more attractive spreads, lower LTVs, possibly lower leverage or improved documentation? Just trying to get a sense of the deal-making environment is becoming even more compelling?
Kevin, thanks for the question. I would say on the margin, not. I think we’ve seen – I think we haven’t seen any step change from the regional bank failures. And on the margin, quite frankly, to be honest, it’s probably slightly more competitive over the last 2 months versus the previous 2 months before that. But – so I would say it’s pretty similar to the environment we’ve experienced over the last 6, 7, 8 months, but there is been no kind of significant change on the margin given the regional banks. Most of those regional banks did not play significantly – excluding Silicon Valley Bank, Signature didn’t play, FRB didn’t play. And so – and we don’t see – we see super regional banks, but we don’t see kind of the typical region bank in our market in any event. So on the margin, I would say not any step changes. Bo?
Nothing to add there. I think on the margin, it’s been slightly more competitive over the last couple of months but still relatively attractive in historical terms, but no step change since the regional banking crisis.
Okay, that all makes sense. And then just one more for me, I am curious if you saw an increase in the memory cost and borrowers in the first quarter and then maybe also touching on what you are seeing quarter-to-date?
Yes, it’s a great question. The answer is yes, but not mostly from LIBOR to SOFR amendments. Obviously, there is a big push given the discontinuation of LIBOR to get everybody on the SOFR. I would say when we look at our amendment activity, the vast preponderance of those were just SOFR LIBOR amendments and some upsides. There was no significant kind of amendments due to underperformance.
Okay, that’s good to hear. Congratulations on really nice quarter. I will leave it there.
Great. Thanks, Kevin.
Thank you. [Operator Instructions] Our next question comes from the line of Mark Hughes from Truist Securities.
Yes. Thank you. Good morning. Did I hear properly, I think you said within the portfolio, the revenue growth was 9%, EBITDA, 17%. Is that correct?
Yes. Let me take a chance to qualify. So the way we think about it, that is the portfolio quarter-over-quarter. If you think about it on a static or same-store basis, it’s a little bit smaller than that, it’s year-over-year, 17% and year-over-year EBITDA growth of about 8%.
Okay. Good. Topline is growing a little faster than EBITDA, that was going to be my question?
Yes, yes, on a kind of on a static basis.
Yes. Understood. And then any different industry mix in the pipeline? I think you said it started to build again in March, any particular type of deal that’s more likely to come to market in this kind of environment?
Yes. Look, I would say, for sure, on the margin our aperture as it relates to industries have opened up given the broad-based dislocation. For example, as noted that we’re involved in an aerospace and defense take private for a company called Macro Technologies. That is a new sector to us, but a very large company, about $400 million plus of EBITDA. Healthcare, for sure, is an active space with a lot of assets coming to market. So given the broad-based dislocation, our sectors have opened up on the margin.
Then any change in your ability to take kind of a leadership role where you’ve got effective control of these investments?
No. I’d say – look, the larger ones are more club deals with like-minded investors where we hold a significant piece, we’re typically the agent or one of the agents or rangers. And so our access to diligence is the same. And I would say the larger deals are most definitely more published.
Thank you.
Thank you. [Operator Instructions] Our next question comes from the line of Jordan Wathen from Wells Fargo Securities LLC.
Hi, good morning. There are a couple of deals we went to the public markets after previously seeking private execution. Should we anticipate any pickup for TSLX next quarter from those two deals?
Sorry, say it again, Jordan?
Should we anticipate any break fees from some of the – there were deals that fell through that were going to go private and then when syndicated, should we anticipate that BDC picks up any of the break fees?
Yes, it’s a great question. You guys are perceptive. I think there is only one – I don’t know if there is a couple, but there is one, that’s Emerson. That credit, I think the public markets have opened up a little bit for higher quality credit. That ended up being a BB credit in a very large company and a BB credit. And there is – there will be an alternative transaction fee that rolls through next quarter’s income statement.
Okay. Great. And then has there been any upward movement on floors or just 1% so kind of the default number in that credit.
I would say – I think floors quarter-over-quarter is up slightly. I’ll give you the exact data, but I think our floors are – our average floor is I think 1% – I think, slightly up quarter-over-quarter or flat quarter-over-quarter, but they range between 75 basis points and 2%, for example, on [indiscernible] 2%.
Okay, understood. Thanks so much.
Thanks.
Thank you. [Operator Instructions] Our next question comes from the line of Erik Zwick from Hovde Group.
Good morning. Wanted to start first and just thinking about the yield in the portfolio and the trajectory of investment income. It seems like the Fed is nearing the end of its hiking cycle. I think you also mentioned that spreads after widening for a while, maybe starting to tighten again, there is a little bit more competition in your markets there. So just curious, are we potentially nearing the peak of the portfolio yield for this cycle? Or is there still opportunity as you’re adding as kind of older loans or being repaid and you’re adding new relationships where you can potentially get some wider spreads. And as you mentioned, the floors are slightly coming up. Just trying to think about the kind of the puts and takes there and what that means for the trajectory of yield and income going forward?
Yes. So the way I would think about it is – look, the front end of the LIBOR curve, I think, is there the SOFR curve so relatively high out of the Fed funds rate. And I think there is a large debate in the marketplace where if the Fed has a near-term cut. And I would take the under a near-term cut. That being said, if there is a near term cut, it’s because those financial stability issues or recession fears, which I think would drive spreads wider in that moment of time, and recreate a good investment opportunity. But the way our income statement typically works is – or the core into the business typically works is that when – in an event where we have a tightening spread environment, we have much more activity-based fees that provide a significant amount of near-term rage the book. And in an event where spreads are stable or wider, obviously, that is good for yields and good for total investment income line and portfolio leverage stays flat to increasing, which drives the ROE. So, I think in the near-term, as you think about it, we remain in a highly volatile environment, which either means that yields will remain stable or in the event that we are, the Fed is cutting, the spreads will widen. So, I am pretty bullish about the near-term of kind of our business as it relates to the earnings profile and the return on equity profile. And the hedge, again, being activity-based income if spreads do tighten.
That’s helpful. I appreciate it. And the second one for me, just thinking about the funding profile, you are in a good position now where you don’t have any notes coming due until the end of ‘24 and still have quite a bit of capacity on your revolver. But if we enter a period where we do go into maybe a moderate or potentially severe recession, and it seems like the banks are already pulling back a little bit on their funding and if investors become a little bit more skittish. Just curious how you think about your funding needs in a tighter environment from that perspective?
Yes. I think – so, I will speak to this on a relative basis and an absolute basis. On an absolute basis, you hit it, which we don’t have any near-term maturities until November of 2024. In the environment where that the environment you called out, spreads are much wider on non-investment grade credit, and although we might have to pay for – we might – our funding might get slightly more expensive, I would say that spreads are going to on our portfolio side because it’s not investment grade, will be, I think much better. So, I think we had this left-hand side of the balance sheet, non-investment grade, issuers were always selective and kept less in flow [ph]. And in the right-hand side of our balance sheet, we are an investment-grade issuer. And the spread kind of – the beta on spreads is much higher on the asset side. So, I feel pretty good about our funding profile on an absolute basis. On a relative basis, I think we are much better positioned than the rest of the sector, which I think will benefit shareholders. Ian, do you have anything to add there?
No, I think you covered all of it, Josh. I think we are always mindful of keeping our options open and being opportunistic, but we just keep a very careful eye on the market and then try to take advantage of windows when they present themselves to them.
Excellent. Thank you for taking my question today.
Thank you. [Operator Instructions] Our next question comes from the line of Robert Dodd from Raymond James.
Hi everybody and congratulations on the quarter. I am just trying to get a handle on the potential on prepay activity, right? And this is a question whether it’s absolute or also whether it’s relative to Q1, which was obviously quite light. But I mean, in your – because it’s always volatile. In your prepared remarks, yes, you did mention prepaid potential and potentially upside to that 13.3 and Bo mentioned some – expect some opportunistic in idiosyncratic payoffs and then also your fair value as a percentage, call-price ticked up this quarter. So, is it fair to say, you expect prepay activity to probably ramp in the second half of the year. And again, the question then is, is that ramp relative to Q1, or just ramp in total? Obviously, this is Bed Bath & Beyond question as well. But anything you can give…?
Yes. Let me give you the unamortized OID on Bed Bath & Beyond. So, let’s start with Bed Bath & Beyond. Bed Bath & Beyond, we know for certainty it is paying off. Yes. So, we don’t know the total net proceeds to us. As we discussed in the prepared remarks, that’s why we have – that’s why we don’t have the call protection in the income statement, and there is a valuation analysis on our balance sheet. But we know that is paying off. I think there are three to four assets in our portfolio that are out to market today. But obviously those are predominantly private companies, and so we have to respect their confidentiality. So, who knows if those trades or not – trade or not. I think one at least is going to trade. But the pull-through on activity-based income is basically a function of what vintage they are and if there is call-protection on unamortized OID. I think on the unamortized OID for Bed Bath & Beyond was $1.4 million – $1.6 million. And then there is about $10.8 million of call of fees capitalized, yield maintenance fees that are above our par. So, it’s – I would say this continues to be a low point on activity-based, obviously in an environment where spreads have widened, that is not shocking. We have a pretty good handle on how the model works, which is in a widening spread environment, activity fees go down, yields go up, leverage goes up and you drive ROEs in an environment where spreads packed in activity-based fees go down leverage is harder to keep, financial leverage is harder to keep and spreads may tighten, but it’s offset by the activity base. So, there are some names out there, and the obvious one is Bed Bath & Beyond.
Got it. I appreciate that color. Now, a follow-up and you partly answered this already, is how on – for lack of a better term, how onerous have you managed to make the co-pro [ph] on new deals in the sense that hypothetically, if we don’t have a bad recession if the Fed stays up here for longer, which I think there is a meaningful probability of that. What – there is always the mix of spreads coming down relatively quickly, potentially, like it’s happened in previous cycles. How – what’s the risk of significant refinancing activity – you get the fees from it, clearly, right? But then the spreads complex potentially a meaningful portion of the portfolio gets maybe part of that, right? So, there is always – to your point, there is a dynamic between fees and refinancing. And how onerous currently is it for your portfolio to refinance relative to where you think something – do you think it would meaningfully actually slow that activity, or could that happen quite quickly if spreads would have come down?
Yes. A couple of different things to parse because I think – one is I think we quote fair value as a percentage of call protection as that gives you some sense of how much embedded economics were in the book. And there is a decent amount of embedded economic in the book. It’s a function of how – I mean, the math for issuers is what’s the payback period compared to the call production, the economic payback period. So, it’s a function of how spreads – how much the spreads tightened. So, if they tighten a little bit, it doesn’t probably increase not much that much refinancing if it had a lot, it probably does. That being said, I think there is a – we have a long history now. I think this is our 37th earnings call. I don’t know, I think I did that math last time in my head. We have – when you look at our team’s ability to create a differentiated portfolio across environments. And so it’s pretty good. And that’s a function that we have a large platform with a – that we get a large top of the funnel where we don’t only do on-the-run stuff, but we do off-the-run stuff. And so this idea like, how much reinvestment risk are you taking, I think is mitigated by the scale of our platform as it relates to the capital we manage and our ability to find interesting things across cycles for our shareholders. And we have been through all these – we have been through many cycles for the last 10 years or 11 years with spreads widening and tightening. And I think the average return on equity for the business is like 13%, and we have always been able to have above-average yields and above average total return on assets and above average return on equity, which is a function of both finding interesting assets and having lower credit costs. And so I continue to be bullish across the environment, and that’s why we like the asset class to do that across environments.
I appreciate that color. Thank you.
Thank you. [Operator Instructions] Our next question comes from the line of Ryan Lynch from KBW.
Hey. Good morning. First question I had was regarding just the potential for any sort of pullback in bank lending activity. I am not really sure how much, it doesn’t really seem like banks really compete with you all too much on kind of your LBO direct lending business. But I was just curious, for the ABL portfolio, for the deals you guys have historically done, has that been a market that banks have played in historically. Obviously, you have won the deals, but are you competing with banks in any of those deals and do you foresee any sort of pullback in that ABL sort of market from banks, given this pullback?
Yes. So, it’s a great question. Let’s start with the pullback for banks. I think that’s most definitely happening. I think there has been a realization that banks had not completely understood their business model. And their business model is lending long and borrowing short through deposits. And those deposits, they have been able to hold at very low cost. And I think everybody is kind of woken up because of the kind of the big systemic issues of bank failures and started moving – the deposit beta is much higher than they thought, they have started moving the consumers and businesses start moving things to money market funds and treasuries and moving things out of deposits. So, I think banks are going to pull back on lending until they understand what their capacity of lending is given the balance sheet on the right-hand side of both varying probably unstable to them. And that will cause banks get close out their options. So, I think your general thesis is right. And I think people are starting to talk about a credit crunch, which I think is good for private lenders. These are business models are distinct. I think when you think about where we compete with banks, you are right on the LBO business. Banks were not financing LBOs on their balance sheet directly. They were in the moving business, not the storage business. But indirectly, they were financing LBOs and that they were buyers of AAAs and investment grade in CLOs and supported capital formation in CLOs, which allows them to be – that capital formation allows them to be in the moving business. So, I think CLO formation on the LBO side continues to be slow and slightly broken with banks not participating in buying those securities given what’s happened on their balance sheet. On where we competed directly with them on the storage business, there is small software companies for sure, on banks, which have cut capacity. And so we have seen Silicon Valley Bank, obviously, out of that business. And then there have been some one or two [indiscernible] not to be named and a couple of regional banks that have most definitely cut capacity in that space. And then on the ABL side, most definitely, I would expect capacity to be cut in that space as well. And so I think that will most definitely create opportunity for kind of generally our specialty lending verticals. Is that helpful, Ryan? I would try to do in a linear way.
No, that’s really helpful to just provide kind of an overall framework for where you guys kind of see the low blending landscape for banks and how that affects you. The other question I had was, you have several different education software loans outstanding. I would just love to clarify, I have looked at those businesses, I believe most, if not all of those businesses are kind of in the – kind of the management of the administration of schools and schooling software business. Can you confirm that, because obviously, there has been some – the actual software businesses that are providing education tools for students and those things that have come under a lot of stress in the public markets from some concerns about artificial intelligence, so I would love you just talk about education…
They are all ERP, right.
Yes, they all manage the back office of the schools themselves. We never got into the content part of that market. That was always harder for us.
Okay. Got it. Alright. I appreciate the time today. Thank you.
Thanks.
Thank you. [Operator Instructions] Our next question comes from the line of Melissa Wedel from JPMorgan.
Good morning. Thanks for taking my questions today. Josh, you have made the comment a couple of times today that you are pretty bullish about the environment right now and the opportunity for, I think TSLX, but also private credit, generally. Given that you have taken leverage a bit higher this quarter from last quarter, I am curious are you willing to take leverage – portfolio leverage up to sort of the top end of your range given the bullish outlook, or does the incremental sort of tighter spread, slightly more competitive environment diminish that appetite at all?
No, I think we are still finding things to do. We are still picking to be – look the range is the range, and I think we will want to take it up to the top end of the range. I would note that we slightly calculate our leverage on a conservative basis, which I think the market is net of cash and net of unamortized financing fees. And so if you look it that way, I think it was slightly lower than what we have said. But I think we are wanting to take it up. In addition to that, that – obviously, Bed Bath & Beyond is coming off. And then we have a Level 2 portfolio of about $15 million that provides incremental capacity as well. And so there is – and Bo mentioned, there is a couple of names in the market. So, it feels like we have capacity, it feels like the opportunity set is still pretty good for us.
Okay. Appreciate that. You also talked about potentially some healthcare assets in the market, and that’s something that you guys would be looking at. Do you provide any context within the healthcare sector because that can be pretty diverse, which areas do you find most appealing? Thanks.
Yes. I mean look, we have always had problems with services given the cost structure and given the exposure to wage inflation. And so the assets we have looked at have not been in the services segment. And obviously, we have a long history of doing biotech, but there has been a whole host of healthcare assets, mostly actually not in the services space that has come to market. Melissa, are you there?
Thank you. At this time, I would now like to turn the conference back over to Josh Easterly for closing remarks.
Great. Well, thank you for participating. Please remember to vote our shareholders in the Annual and Special Meeting. Obviously, Mother’s Day is coming up. So, be kind to all your mothers and I most definitely appreciate my wife. And so we will see in the summer and on our Q2 earnings call. Thanks.
Thanks everyone.
This concludes today’s conference call. Thank you for participating.